Bharat Electronics (BEL) reported a strong beat in top line and Ebitda which grew 24% and 8% y-o-y (9/7% higher than estimate). Key highlights: (i) strong top line in Q4 led to healthy 18% y-o-y FY17 top line, an impressive 2x growth versus decade average; (ii) Q4FY17 Ebitda margin at 24.5% (down 350 bps y-o-y) was impacted by sharp 66% y-o-y spike in salary bill (7th Pay Commission impact), despite which FY17 margin came a strong 20.5% (up 50 bps y-o-y); and (iii) new orders stood at Rs 165 bn (flat y-o-y), implying healthy revenue growth visibility with order book of Rs 400 bn (25% y-o-y). We reiterate our conviction on BEL as delineated in our recent detailed note, where we highlighted a strong pick-up in execution with stable operating margin. Maintain Buy with TP of Rs 200 (23x FY19e earnings) given a reasonable 20/14 % CAGR in order book/earnings over FY17-19e.
18% spurt in top line key surprise; sustainable OPMs stay strong
BEL’s execution was robust in Q4FY17 with 24% y-o-y growth, led by execution of large value projects bagged over the past 12-15 months. This led to an impressive 18% y-o-y spurt in FY17 top line (2x past 10 years’ average). Despite some low margin orders & sharp rise in salary bill in Q4, FY17 Ebidta margin improved 50 bps y-o-y to 20.5% which is again a positive surprise corroborating BEL’s high product throughput from its plants despite rising share of projects business.
Robust order book & profitability visibility over 2-3 years
Our bottom-up appraisal of defence projects lends comfort w.r.t. BEL’s double digit order book growth over FY17-19e led by large value surface-to-air missile projects. Also, the company’s focus on R&D & integration capability with reasonable 65% share of in-house value addition impart margin comfort despite rising systems business.
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Outlook and valuations: Best defence pick; maintain ‘BUY’
Despite more than 4x returns in the past 3 years, BEL still remains our preferred pick in the defence sector given its unparalleled positioning in the strategic defence electronic space, which we believe remains a key business MOAT. Key value driver over the next 2-3 years remains a healthy double digit growth in order book, sustainable OPMs and pick up in execution around large systems over FY17-19e. We maintain ‘BUY/SO’.
BEL, one of India’s largest defence PSUs, specialises in manufacturing defence electronics. It is emerging as a key beneficiary of increase in defence capital expenditure. The government’s Make in India drive is likely to encourage domestic manufacturing. Further, domestic companies, including BEL, are likely to benefit from key changes in government policies, notably the offset clause (30% of an order must be subcontracted domestically). Despite the entry of private players, we believe BEL as a defence PSU is poised to benefit from increased defence capital expenditure and the offset policy. BEL has a strong order book, equivalent to over five years of revenues providing excellent visibility and hence is not affected by near term lull in intake. Its order book is slated to grow over the next few years because of steady demand for its existing product range; potential orders from high value projects.
The defence market is monopolistic in nature with GoI being the sole buyer of defence equipment, which puts suppliers such as BEL at a disadvantage. Further, defence procurement procedures are complex and past experience suggests that they have tended to move at an extraordinarily slow pace. This has a dual impact: the equipment flow may not occur and it leads to a high degree of lumpiness in the order book.
The government has shown increased intent of involving private players in the defence procurement process and to develop an active private sector supply to the armed forces. We believe DPSUs have strong competitive advantages over the private sector in the near– to-medium term. However, incremental competition, particularly for offset contracts, could make a negative impact on BEL’s margins.
Company description: Established by GoI under the Ministry of Defence in 1954 to meet the specialised electronic needs of the Indian defence services, BEL has grown into a multi-product, multi-technology and multi-unit company, serving the needs of customers in diverse fields in India and abroad. BEL offers products and services in a wide spectrum of technology like radars, military communications, naval systems, electronic warfare systems, telecommunications, sound and vision broadcasting, opto-electronics, tank electronics, solar photovoltaic systems, embedded software and electronic components. The company also provides turnkey systems solutions like command control communication & computer intelligence (C4I), covering the requirements of all three forces.